Do nations have an “equity culture”?

While moderating a debate on the state of India’s capital markets at a conference in Mumbai recently, I listened helplessly to a vociferous argument by the head of a retail brokerage firm on how Indians lack an “equity culture”.

He further lamented that Indians do not partake in investing their savings in the stock markets, unlike citizens of developed countries, and insinuated that such “culturally” challenged Indians are playing spoilsport to the India growth story.

Are stock markets and equity investing a proxy barometer for a nation’s economic development? Is equity investing a “culture”?

The World Bank in its indices of World Development indicators lists the ratio of stock market capitalisation to gross domestic product (GDP) as one of the hundreds of parameters that it monitors to ostensibly evaluate economic development of nations. Analysis of that indicator over a 25-year period reveals interesting trends.

Contrary to what most people believe, stock market capitalisation, as defined as the equity value of all companies listed on the stock exchange, is significant in the US, the UK and Canada, but not in Germany, France and Italy.

The average stock market capitalisation to GDP ratio for the US/the UK/Canada as a group over a 25-year period is 114 per cent. For Germany/France/Italy as a group, the average is 48 per cent. For Asian countries of Korea and Japan, it is 65 per cent.

For the newly formed BRIICS consortium of Brazil, Russia, India, Indonesia and China, the stock market capitalisation to GDP ratio is 41 per cent.

In the 21st century (2000 - 2013), the stock market capitalisation to GDP ratio for these four country groups are US/UK/Canada (120 per cent), Germany/France/Italy (55 per cent), Korea/Japan (72 per cent) and BRIICS (53 per cent).

Clearly, stock market capitalisation is neither an indicator nor a precondition for economic growth, as evidenced by the difference in the percentages between US/UK/Canada country group and Germany/France/Italy country group.

Developed nations in the continental European region have consistently had a lower stock market capitalisation to GDP ratio than their North American and British counterparts.

Germans and Japanese invest 20-30 per cent of their household financial savings in equities, on an average, while the Americans and British invest 50-60 per cent of their savings in equities.

Surely, education or awareness of equity as an asset class cannot be a significant reason for why Germans don’t embrace stock markets the way Americans do, because Germany is as literate a society as America is, if not more.

Then can this notion of “equity culture” be a reason for this difference?

As the popular narrative goes, India began to unshackle from its socialist legacy to embark on an Anglo-Saxon model of economic development after the landmark 1991 Budget of the then Finance Minister Manmohan Singh.

In 1990, India’s stock market capitalisation to GDP was 12 per cent. It is now 70 per cent. In today’s dollar value, the market capitalisation of India’s stock market has risen from $13 billion in 1990 to $1.5 trillion now; that is a 114-fold increase.

But these headline statistics hide more than they reveal. The rise in India’s stock market value is driven almost entirely by foreign investors.

Between 2000 to 2013, foreign investors invested a net of $120 billion in the stock markets, compared to a mere $17 billion by Indian investors, either through mutual funds or directly in stocks.

Paradoxically, domestic investors withdrew money from the stock markets in six out of the 13 years between 2000 to 2013 when the GDP grew five times as did the BSE Sensex.

When India was growing richer and when the stock markets were rising rapidly, Indians were not investing in the stock markets commensurate with their rising income levels.

In this time period, $284 billion of incremental savings in banks and $166 billion of additional gold (in current dollars) were accumulated by Indians vis-a-vis a mere $17 billion in stock markets.

Foreign investors invested $120 billion in the stock markets in this period, almost as much as Indians’ additional gold accumulation. For every dollar of incremental GDP, 18 per cent goes into savings bank account, 8 per cent in gold and a paltry 1.5 per cent in equities.

It is indubitable from data that the stock market’s Himalayan climb over the past decade has largely been a foreign investor phenomenon and not driven by Indians rushing to stock markets to invest their savings.

There are numerous conjectures on why Indian investor participation in equities is low, including trust deficit in markets, misleading brokers, market volatility, lack of awareness and so on. India’s capital markets being dominated by a handful of speculators has further eroded confidence in the markets.

However, perhaps, there is a cultural aspect to this, after all.

I ponder why that on the one hand, the Reserve Bank of India is fervently attempting to prevent millions of Indians from giving their money to chit funds voluntarily, on the other, the Finance Minister and market regulator SEBI are struggling to convince households to invest in well regulated stock markets with alluring tax incentives.

The jaded argument of ease of investing black money into chit funds vis-a-vis equity markets is not fully explanatory because even with rising income levels, household savings in equities has stayed constant.

I am no sociologist but by incessantly exhorting Indians to stop buying gold and invest in stocks instead, as finance ministers, regulators, mutual fund industry, brokerage companies do, are we simply barking up the wrong tree? Is India more like Germany than the United States, in its “equity culture”?

The writer is a former CEO of an investment bank, and acknowledges the inspiration of S Gurumurthy for this analysis

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